Friday, February 24, 2023
U.S. and International Equities
The major market averages this week sold off with the majority of sectors ending in the red. Markets have now finished lower for three consecutive weeks amid concerns with equity valuations in the face of investor skepticism over the disinflation narrative. International markets also followed suit, ending the week negative.
The S&P 500 is currently trading at a trailing 12-month price-to-earnings (P/E) ratio of 19, which is below the 10-year average of 19.5. This represents a significant reversal down from the 2021 high of 29.9 and shows that equity investor exuberance has waned. A stronger-than-expected labor market, hawkish Federal Reserve (Fed)commentary, and Friday’s hotter-than-expected personal consumption expenditures data has convinced investors the Fed will hold interest rates higher for longer in order to curb pricing pressures.
Fixed Income Mostly Lower as Yields Increase
The Bloomberg Aggregate Bond Index finished the week in the red as yields increased for the third straight week. Bonds have been directly influenced by hawkish Fed speak in the wake of higher-than-anticipated inflation data. In addition, high-yield corporate bonds, as tracked by the Bloomberg High Yield index, finished the week marginally higher and continue to lead all bond markets in year-to-date returns despite economic growth concerns.
While yields and stocks remain negatively correlated, the correlation between the S&P 500 and 10-year yields has recently weakened. In general, this suggests stocks are less sensitive to higher rates compared to the past several months
The three major Bloomberg tax-exempt muni indexes all closed lower last week; however, the underperformance of municipals has yet to result in tax-exempts getting cheap enough, relative to corporates, to spark demand from banks, insurance companies, and other investors subject to the 21% federal income tax bracket. Retail investors continue to add money back to the asset class. While valuations are fair to slightly rich, the positive fundamentals and improved technicals make for an interesting opportunity set for investors.
Energy prices finished marginally higher this week even as traders are concerned that the Fed will not pivot on monetary policy given the recent inflation prints. The major precious metals, gold and silver, ended the week lower given future economic growth concerns.
Economic Weekly Roundup
Core inflation, stripping out volatile energy and food prices, increased 0.6% in January from a month ago, representing the fastest monthly clip in seven months. This pushed the annual rate of inflation to 4.7% from an upwardly revised 4.6%. Given the most recent reading, the Fed will continue its rate hiking campaign for a lot longer than economists anticipated just a few weeks ago.
In January, real personal spending rose 1.1% as consumers were seemingly unfazed by the inflationary landscape. Present Fed policy has yet to fully impact consumers, showing the policymakers have more work to do in slowing down aggregate demand. The Fed may still decide to hike by 0.25% at the next meeting, but this report suggests they will likely continue hiking into the summer.
The minutes from the Federal Open Market Committee’s (FOMC) latest meeting provided little fanfare. After the latest FOMC meeting, investors received a strong jobs report and robust consumer spending so the minutes did not incorporate those data. With that being said, wage growth in excess of 2% inflation without reasonable productivity growth will make for an inflationary regime. Last year’s poor productivity growth contributed to imbalances between demand and supply, adding upward pressure on inflation. Some policymakers were concerned the labor market could remain tighter for longer, placing upside risks to inflation.
European Economic Landscape
The European economic landscape appears to be better than many economists have anticipated given this week’s positive Purchasing Managers Index (PMI) reports. The U.K. appears to be on course to sidestep a forecasted recession as businesses reported an unexpected bounce in activity as well as receding price pressures this month, according to the nation’s PMI survey. In addition, Eurozone business growth reached a nine-month high on the back of better-than-expected growth in services.
German Business Outlook and Inflation Report
German Ifo business outlook improved for a fifth straight month in February, though it slightly missed expectations. Germany’s January inflation rate showed little signs of easing as energy and food price pressures remained high given the Russia-Ukraine conflict. Energy product prices were 23.1% higher year-over-year (YoY) amid government relief measures. Excluding energy prices, the inflation rate came in at 7.2%. Food prices increased over 20% YoY, more than doubling the overall inflation rate.
January Leading Economic Indicators
The Conference Board’s Leading Economic Index (LEI) declined again in January, although the one-year decline slowed. The index data is consistent with the most recent consensus estimate of Bloomberg-surveyed economists, which saw a small increase in expected U.S. and global growth in 2023, although at still tepid levels, and a small decline in recession risks over the next 12 months. A declining Conference Board LEI that has crossed below a -5% one-year change has historically seen below average S&P 500 Index returns over the next six months, but above average returns over the next twelve months
Initial and continuing claims for the latest week came in below economists’ expectations as well as the prior weeks’ report. That being said, labor markets continue to show limited signs of softening amid increasing layoffs.
The following economic data and potentially market-moving events are slated for the week ahead:
- Monday: Durable orders (Jan), pending home sales (Jan)
- Tuesday: Wholesale inventories (Jan), FHFA Home Price Index (Dec), S&P/Case-Shiller (Dec), consumer confidence (Feb)
- Wednesday: S&P Global PMI Manufacturing (Feb), construction spending (Jan), ISM Manufacturing (Feb)
- Thursday: Weekly initial and continuing unemployment claims, productivity (Q4)
- Friday: PMI composite (Feb), S&P Global PMI Services (Feb), ISM Services PMI (Feb)
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